Applying History in Real Time: A Tale of Two Crises - Niall Ferguson

well I thank you Karina it's a great pleasure to be here this evening and I'm going to give a talk with the title applying history in real time a tale of two crises it's nearly half a century since James Joel gave his inaugural lecture at the London School of Economics entitled 1914 the unspoken assumptions in it Joel argued that one couldn't understand the outbreak of World War one purely in terms of the stated calculations of the key actors as recorded in the diplomatic documents of the time of equal if not more importance were the unspoken assumptions they made because it was these Joel argued that predisposed so many of the decision-makers to exaggerate the benefits and understate the costs of going to war since its incorporation as a quote scholars paradise in 1930 the Institute of Advanced Study as I think it's fair to say devoted a minority share of its resources to the study of history it's much better known for its mathematicians and its physicists and even the best-known of its writers of history George Kennan wars as John Gaddis has shown in letís with such formidable colleagues as John from Lyman mathematicians and historians sought their own tables in the cafeteria kenan recalled of his time here I wonder if that's still the case I do hope not and yet to borrow a phrase from the Institute's founding director Adam Flexner there is no more useful useless knowledge than knowledge of the human past it wasn't a natural disaster but an historical calamity the German Curtis as Friedrich Monica called it that populated this Institute with refugees from Germany I'm glad to see that today the Institute lists among its scholars current research projects reconstructing history using novel sources such as ancient DNA and establishing the origins of modern democracy and human rights in this talk I'll focus not so much on unspoken assumptions in Joel's sense as on semi articulated explanatory frameworks and I shall do so not in the context of the First World War but with respect to too much more recent and somewhat smaller those still very consequential crises one military the other financial the first was the terrorist attacks on New York and Washington in September 2001 the second the financial crisis that had its most dramatic expression in the bankruptcy of the investment bank Lehman Brothers almost exactly seven years later to put it very simply this lecture is about the different ways we think about security singular and securities plural having spent much of the last few years writing books about financial history and diplomatic history I've been struck by the fundamental differences in conceptual frameworks in the two realms of finance and foreign policy tonight I should like to suggest very tentatively that practitioners in each field might learn something from studying the mode of thinking in their counterparts and vice-versa there are dangers to confining good minds in intellectual and institutional silos notably groupthink and what the Germans call subject idiocy and I take it to be one of the missions of the Institute to avoid precisely those siloed vices so how broadly speaking do theories of risk management differ between the realms of national security and financial stability asset managers as some of you I have no doubt are aware have long been equipped with theories that make explicit that the core object of risk management is the return on a portfolio and that the possibility of higher returns must be set against the risks of any given strategy high returns with high volatility are not necessarily preferable to modest returns with low volatility a portfolio is rebalanced on a daily even hourly basis in response to a relentless flow of news relatively few of any people who work on national security think in those terms rather they're trained to think of big decisions often binary in character war peace and a hierarchy of decision-making at the top of which sits a president prime minister or prince with whom the proverbial box stomps on the other hand there's no doubt that systemic scenario planning is much rarer in the financial world than in the political world when shell introduced the practice of scenario planning in the early 1970s it was regarded as highly innovative there are still many businesses including major asset managers that don't take this approach by contrast it was second nature to any specialist in cold war security to think in terms of scenarios indeed that practice of systemic formalized wargaming can be traced even further back to the early 19th century Prussian army and continues to be a large part of what military planners do how are we to explain these differences well I think the best answer is historical the history of financial risk management is a fundamentally different one from the history of national security strategy the evolution of Modern Portfolio Theory took one direction after the term was introduced by Harry Markowitz in 1952 in more or less the same timeframe the evolution of deterrence theory went another way as thinkers such as bernard brody henry kissinger and tom Schelling grappled with the strategic dilemmas of the nuclear age whereas portfolio theory postulated a multi variable universe in which downside risk could be reduced by diversification and various hedging devices deterrence theory was to a significant degree an offshoot of game theory there were essentially two players in the cold war game which resembled an extreme version of the prisoner's dilemma with the worst outcome being the total destruction of the world the intermediate outcome being cooperation they told as it came to be known and the best outcome being the submission of the other side without the firing of a single missile the eventual outcome anyone involved in the diplomacy of the Cold War had to contemplate and attach a probability to all three of these scenarios at any given moment by contrast investors couldn't easily hedge against the worst-case scenario of the Cold War there are no options that can be exercised in the event of the end of the world so financial risk managers were best advised to do their jobs as if the end of the world simply wouldn't happen well even if there's some better explanation of the divergence than there's no denying the contrast between the conceptual framework taught to students of Finance today and that taught to students of international relations the tools of financial risk management include futures contracts : poot options as well as interest rate swaps currency swaps and credit default swaps wide use is made of Meza measures such as the Sharpe ratio the average return earned in excess of the risk-free rate per unit of volatility or total risk or more controversially value at risk students are taught to understand that not all distributions of risk and normal there can and indeed often are be fat tails by contrast I'm not aware of any course on international relations that encourages students to think of national security as a portfolio of national assets and foreign policy as a set of strategies designed to maximize risk adjusted returns with hedges designed to minimize downside risk moreover it's a distinctive feature of the way the United States educates its elites that relatively few people are well versed in both financial risk management and national security strategy at Harvard despite my best efforts over 12 years economics concentrators could quite easily graduate without having studied a single foreign policy crisis now please let me make clear I'm not suggesting that one approach to risk management is necessarily superior to the other on the contrary recent experience casts grave doubt on both conceptual frameworks as I hope to show you prior to 2008 highly formalized approaches to financial risk management led to an excessive reliance on mathematical models that proved disastrously fallible contemporary approaches to national security his strategy earned in the opposite direction lacking in a formal framework for risk measurement they created opportunities for reckless and ultimately very costly decision based on gut instinct what both approaches missed and I think continue to miss was any systematic attempt to learn from history and any real appreciation of the implications of uncertainty as opposed to calculable risk for decision-making in two dramatic crises inside 10 years the American public was confronted by disasters for which the federal government seemed singularly ill-prepared the terrorist attacks of September the 11th 2001 and the financial crisis that erupted almost exactly seven years later with the failure of Lehman Brothers on September the 15th 2008 now it's not my intention tonight to play Monday Morning Quarterback and to argue as others have that the Central Intelligence Agency should have foreseen that al Qaeda was planning a major operation before 9/11 and that the Federal Reserve should have understood that Dick Fuld was driving Lehman Brothers towards a cliff before September 15 2008 the more interesting question in my view is how well the relevant agencies coped with these crises immediately after they had happened and in particular how well the decision-makers were served by their own conceptual frameworks now let me right away make clear that I appreciate how unlike one another these two crises were there was an immense difference between coordinated acts of violence intended to kill defenseless people in their thousands and uncoordinated acts of financial incompetence that were intended merely to enrich a comparable number of people the terrorist attacks of 9/11 immediately commanded the attention of the president and the most senior members of his administration the National Security Council existed to coordinate the actions of the various departments and agencies concerned the financial crisis by contrast was not immediately seen as a problem for the White House there was a conspicuous lack of any coordinating body although in practice the Federal Reserve's open markets committee the FOMC played the leading role the public response was different to if you remember the electorate rallied around President Bush in the aftermath of 9/11 giving him a mandate from more or less any measure that satisfied the popular appetite for retaliation by the fall of 2008 by contrast Bush was a lame duck his Wars deeply unpopular and his approval ratings sank even farther in the face of financial panic and looming economic hardship most commentators today would I think be inclined to argue that later crisis was handled better than the first in the sense that although the economic recovery was - most economic forecasters surprisingly slow in coming the international financial system appears to be in better shape today than the Islamic world and particularly those countries where the United States sent troops after 9/11 all that having been said the two crises nevertheless had certain common features first both crises were not black swans in the sense of wholly unforeseen shocks the Bush administration had certainly been warned of the terrorist threat posed by Al Qaeda and as is well known the 9/11 attacks were not the first attempt to damage the World Trade Center in New York the financial crisis was not a bolt from the blue but an escalating process that can be traced back to early 2000 seven when the first financial ramifications of defaults and subprime mortgages made themselves felt Bear Stearns had already come to grief in March 2008 in essence both crises arose because the responsible agencies underestimated the scale of the threat posed by an al-qaida attack and by the Lehman bankruptcy second common factor in each case after disaster struck the administration unhesitatingly saw the importance of acting in concert with US allies in that sense both crises were from the outset international third and most important for our purposes this evening nine eleven and nine fifteen required government agencies to react swiftly and creatively the strategic response had to be improvised because no plan existed for the overthrow of the Taliban regime in Afghanistan and no plan existed for countering the generalized run on financial institutions triggered by Lehman's failure finally because of the enormous uncertainties they confronted decision makers had little choice but to rely on their own conceptual frameworks there weren't really enough data to make the decision on in both cases then historical precedents were cited to bolster arguments but never in any systematic way this is a really important point that I'll come back to even on the same day as the 9/11 attacks on New York and Washington President George W Bush and his most senior officials ruled out relying on missile strikes to retaliate against the suspected perpetrators that decision was taken almost at once in that respect they defined their intended course of action in Contra distinction two measures taken by previous administrations another early decision which Bush took after consulting only his national security adviser and now my colleague at the Hoover Institution Condoleezza Rice was that the administration would and I quote make no distinction between those who plan these acts and those who harbor them those were the words of the president's address to the nation on the night of September the 11th also on the same day as the attacks the first suggestion was made by Secretary of Defense Donald Rumsfeld that and I quote the US response should consider a wide range of options and possibilities the secretary said his instinct was to hit Saddam Hussein at the same time not only Bin Ladin this was part of a tendency to regard the crisis as in the president's own words a great opportunity for more than mere retaliation against Al Qaeda and their taliban protectors and I quote again secretary Powell said the United States had to make it clear to Pakistan Afghanistan and the Arab states that the time to act was now he said we would need to build a coalition the president noted that the attacks provided a great opportunity to engage Russia and China secretary Rumsfeld and urged the president and the principals to think broadly about who might have harbored the attackers including Iraq Afghanistan Libya Sudan and Iran director of Central Intelligence George Tenet said the United States had a quote 60 country problem 6-0 now at one level this discussion was eminently justifiable Islamic terrorist networks already extended far beyond Afghanistan any attempt to deal with al Qaeda would require at least some assistance from neighboring countries in particular Pakistan nor was it unreasonable for the President to ask Richard Clarke to quote if Saddam did this at a time September the 12th when much was still unclear about who was behind al-qaeda in any case Bush's decision three days later was quite clearly to prioritize a swift move against Afghanistan including quote boots on the ground no one who studied the available documents can fail to be impressed by the president's good judgment on a range of decisions that were anything but self-evident Bush even understood better than his own intelligence chiefs that an effective counterterrorism strategy would need to be probabilistic quote we're going to have to make some bets about what's likely he told tenet meaning that all not all conceivable US targets could possibly be protected had the administration confined itself to the destruction of al-qaeda and its proven supporters Bush's presidency might today be admired even at Princeton few contemporaries including members of his own administration foresaw that the Taliban regime would be so swiftly toppled the us-led operation began on September the 24th by November the 13th the Taliban had fled Kabul and yet the eagerness of elements within the Defense Department to instrumentalize the 9/11 crisis in order to justify an attack on Iraq was surely questionable even if the idea was initially put on the back burner it's far from clear from where Paul Wolfowitz got his quote far more than 10 percent probability that Saddam was behind the 9/11 attack it's all too clear that from an early stage the focus on WMD weapons of mass destruction was intended to find a legitimation for Saddam's overthrow even more problematic was the way rival government agencies sought to exploit the crisis for bureaucratic a let me ask a question did decision makers in September 2001 seek to apply history to use historical analogy to think about the problem they confronted well the answer is that some did but only fitfully the Pearl Harbor of the 21st century took place today the president confided in his diary late on the night of the attacks inevitably perhaps Vietnam was sometimes mentioned this explains Rumsfeld's early prohibition on pauses in military action but that was generally to bolster the assumption that relatively few troops would need to be committed in Afghanistan and not for very long everyone concerned was aware that others the Soviets in the 1980's the British Empire in the 1840s had found Afghanistan an exceptionally dangerous country for a foreign army but again these precedents were cited to justify the small-scale and short duration of the planned intervention those who'd been involved in the 1990 Gulf War also drew parallels that they were more struck by the differences than by the resemblances the same applied to the Clinton administration's Balkan interventions we're going to wish this was the Balkans commented condi rice prescient Lee during the weekend of talks at Camp David on September 14th and 15th was more inclined to stress the unprecedented nature of the challenge he faced this was he told Karen Hughes no kind of enemy that we are used to this is a new world he said on September 13th we need new options Rumsfeld agreed this is a new mission this is a completely different kind of war Bush told Hughes in September the 23rd even the principles that the State Department were prone to Masonic rhetoric the world has changed it is time to change the world was the last of secretary Powell's talking points September the 13th this kind of thinking shortly encouraged the president and his speech writers in the direction of a rhetorical overreach that was pregnant with future danger our war on terror begins with al Qaeda but it does not end there the president declared before a joint session of both houses of Congress and September the 20th it will not end until every terrorist group of global reach has been found stopped and defeated when this pledge mutated into the explicit threat of pre-emptive action against an alleged axis of evil Iraq Iran and North Korea the die was cast by April 2002 if not earlier the president had taken the fateful decision to invade Iraq to read the documents produced by the financial crisis of 2008 is to enter a parallel universe to encounter conversations so different in their language and conceptual framework that it's hard to believe the events belong to the history of the same administration that had weathered the storm of 2001 an important difference between 2001 and 2008 was that the failure of Lehman Brothers was essentially willed by the US government only cranks believe this to be true of the 9/11 attacks that the bank was in difficulties was widely known before September indeed to have thought that it was not after the events of that spring would have been bizarre as Lehman was in some respects just a large version of Bear Stearns roughly twice the size the Federal Reserve Bank of New York and the Treasury were aware of the potential bankruptcy of Lehman as early as September the 8th well there's certainly no need tonight to describe in detail the events of the subsequent week suffice to say that the rationales offered subsequently for allowing Lehman to go bust differed markedly from those that were offered at the time later Fed Chairman Ben Bernanke argued that there was a legal obstacle on section 33 of the Federal Reserve Act 2 lending to Lehman as much as he believed was necessary at the time however the argument was the practical one a matter of judgment not law that and I quote investors and counterparties had had time to take precautionary measures tim geithner of the New York Fed declined a request from Lehman management to turn their firm into a bank holding company in order to make it eligible for fed us it's now it may be that Hank Paulson the Treasury secretary believed he could Bluff the so called heads of family the CEOs of the big commercial banks into bailing out Lehman as the hedge fund long-term capital management had been bailed out in 1998 ten years before if so he didn't succeed most people certainly most senior people at Lehman assumed the fate of Bear Stearns provided a precedent for government intervention they failed to see that exactly the opposite was true for political reasons and to placate the god of moral hazard the fate of Bear Stearns necessitated a worse fate for Lehman as Geithner and Paulson explained their wars quote no political will in Washington for a bailout of Lehman it's I think beyond any doubt that officials at the Treasury and the Fed badly underestimated the scale of the disaster apart from anything else there later inconsistent treatments of Morgan Stanley and Goldman Sachs which were granted bank holding company status to give them access to fed support precisely what Lehman Brothers was denied gave the lie to the argument that legally the Fed had no alternative but to let Lehman fail it wasn't just that this was and I quote the largest most complex multifaceted and far-reaching bankruptcy case ever filed in the United States more importantly because Lehman was a highly central node in the international financial network its bankruptcy precipitous today cascade of financial panic not just in the United States but around the world now my concern here is with the way one of the key government institutions involved in the decision-making process the FOMC reacted to the unfolding disaster unlike for the National Security Council all for the president's war cabinet in 2001 transcripts of the FOMC's meetings and conference calls have been made public so we can follow with some precision the evolving reactions of the committee's members a number of resemblances to the aftermath of 9/11 immediately jump out first international considerations were very near the top of the agenda in the days following the Lehman failure Ben Bernanke the Fed chair was very quick to understand the overseas impact of the bank's collapse and he hastened to secure authorization for large swap lines to ensure that the major central banks of the rest of the world had all the dollar liquidity they needed secondly the committee moved swiftly seeing that the failure of Lehman implied danger not only for its competitors but also for money market funds hence the speed with which the primary dealer credit facility was broadened to allow types of collateral that just days before had been refused when Lehman offered them thirdly the majority of members understood that open-ended commitments would be more effective than ones with arbitrary caps as William Dudley then manager of the open market account put it quote I think the important thing here and what we're going for is credibility in a crisis you need enough force more force than the market thinks is necessary to solve the problem in some ways this was a financial version of President Bush's reasoning in the immediate aftermath of 9/11 yet the committee was hampered by the inertia of the feds own forecasting model I don't think we've seen a significant change in the basic outlook reported Fed chief economist David J Stockton to the FOMC on September the 16th and certainly the story behind our forecast is that we're still expecting a very very gradual pickup in GDP growth over the next year events would make a mockery of this and similar statements Bernanke grasped that the US economy was already in recession which it was but Stockton sanguine forecast helped persuade a majority of committee members to oppose a rate cut as if there was still some reason to worry about near-term inflation only a very few people in that room appreciated at this early stage the true nature of the feds position Bernanke candidly admitted that he felt and I quote decidedly confused and very muddled about the ad hoc way in which decisions were being made with the feds most recent data lagging the rapidly deepening crisis much turned out to depend on the historical knowledge of members of the committee this was variable at 63 Gary Stern chief executive of the Federal Reserve Bank of Minneapolis was among the oldest people in the room on September the 16th he called it quote the most severe financial crisis certainly that I have seen in my career 38 year-old Kevin Walsh later joked that it was the toughest economic period I can remember in his lifetime a complete list of the historical analogies initially offered by FOMC members extends from March 2003 the eve of the Iraq invasion all the way back to the plague of the 14th century because in the words of Richard Fisher of the Dallas Fed and I quote the monks in that period who dominated society reverted to the old orthodoxy learned from the Greeks they did not learn what the nuns learned is that you learn from practice gallows humor I believe surprisingly the first mention of the Great Depression didn't come until October the 7th and it came from Jeffrey Lacker of the Richmond Fed who suggested they are quote reflect on whether what we're seeing is genuine fundamental uncertainty about counterparties and whether our lending is the equivalent of pushing on a string to use another metaphor from the Great Depression quoting Keynes I see Jeff was Bernanke's sole comment it wasn't until October the 29th that Bernanke himself after suggesting they were now facing the worst recession since World War two offered the following sober judgment I'm going to quote at length here from Bernanke there has been some comparison of this to the Japanese situation meaning in the period after 1989 I'm beginning to wonder if that might not be a good outcome the advantage of the Japanese was first of all that they were isolated the rest of the world was doing ok and they were able to draw strength from their exports and the rest of the global economy although they had very slow growth they never really had a deep recession or big increases in unemployment I think we are looking at perhaps a much sharper episode and our challenge will be to make sure that it doesn't persist longer I do think that one lesson of both Japan and the 1930s as well as other experiences is that passivity is not a good answer more often than not however the early post Lehman discussions on the FOMC were about economic models rather than historical precedents only slowly did committee members become dismissive of this approach when Bernanke sought to sum up the position on October the 29th it was to history not to a model that he appealed and I quote again history suggests that whenever a financial crisis becomes sufficiently severe ultimately the solution is a fiscal solution and we will have a fiscal solution but I just note that in all of these fiscal dynamics there is a political economy overlay you have to get to the point that it is not only the right policy to induce fiscal support but also that it is politically possible by mid-december Dudley went so far as to suggest that quote we could have default rates greater than those of the Great Depression after 9/11 President Bush had a keen sense that he was leading the country into new territory in effect the Fed was doing the same after 9:15 as the international financial system and the US economy showed increasing signs of being in freefall so numerous were the policy innovations under discussion that Richard Fisher of the Dallas Fed worried that they might be quote at risk of being perceived as migrating from the patron saints of milton friedman and john taylor to a new patron saint rube goldberg yet the crucial argument that persuaded even the most skeptical members of the FOMC to support these innovations was an historical one that the alternative might be to rerun the Great Depression two points are very striking here the first is how little use Chairman Bernanke made of his own expertise in the financial history of the 1930s the second is the decisive role played by the one man at the table with a background that combined international politics and economics on October the 29th in response to those opposed to a 50 basis points cut in the Fed Funds rate Geithner argued passionately for action quote I don't see a good case for monetary policy gradualism in the current context the risks are too great if we're too tentative the damage to the financial system and to the real economy could be much greater and much harder to correct if we end up doing too much we can always adjust that's an easy problem to solve it just requires will with global financial markets placing progressively more weight on a very severe global recession the keep our powder dry and reserve our remaining ammunition arguments don't seem that compelling to me we don't have much ammunition left in the Fed Funds rate anyway I think this basic risk management choice really involves three dimensions of judgment one is about the relative probability of alternative outcomes the second is about the relative consequences of or the damage caused by those alternative scenarios importantly it also involves a judgement about the ease of correcting adjusting or mitigating the consequences of being wrong end quote by the end of 2008 most members of the committee had been persuaded that any policy capable of averting a second Great Depression should be tried even if there were insufficient fiscal stimulus being provided by Congress and even if massive expansion of the Fed balance sheet might ultimately lead to higher than desirable inflation let me draw my remarks to a conclusion sigh with relief I won't be offended am I seriously arguing that the security studies specialists should introduce into their conceptual framework concepts such as Value at Risk the theory of option pricing fat tails black swans and the like No conversely do I really want bankers and financial regulators to familiarize themselves with deterrence Theory no probably not rather the argument I want to make is that both schools of risk management both institutionalized on campuses such as the one here at Princeton both need to learn more systematically from history of course academics do well to show humility when they criticize those who have to take decisions at the highest level of government if the hardest decision you have ever made was in a ten year case then you can scarcely imagine how difficult it was to decide on the overthrow of the Taliban or that of Lehman Brothers the point of this lecture isn't to judge with the great benefit of hindsight the decisions that were made in September 2001 and September 2008 rather it's to assess the decision-making discussions as they happened and on the basis for the knowledge that the participants had at their disposal at the time so my conclusions are modest ones those who determined US policy in the wake of the great disasters of 9/11 and 9/15 were over reliant on conceptual frameworks that did not give a formal role to history in both cases analogies were thrown around in a somewhat casual way 9/11 was Pearl Harbor Al Queda where Islamofascists Saddam Hussein was Hitler Baghdad in 2003 would be Paris in 1944 when President Bush lost patience with the difficulties of establishing democracy in Iraq his questions epitomized the problem where's the leader where's George Washington where's Thomas Jefferson where's John Adams for crying out loud there was a similar scattergun quality to the historical analogies discussed by the FOMC in 2008 remember the medieval monks a more systematic assessment of relevant analogies would surely have been beneficial secondly what Henry Kissinger long ago called the problem of conjecture the impossibility of having certainty about the consequences of action and inaction was insufficiently appreciated in 2001 the argument for treating the 9/11 attacks as an opportunity for a large-scale geopolitical reordering wasn't subjected to sufficient scrutiny and far too quickly became the basis for a policy that misunderstood the problem of conjecture preemption as Kissinger understood is a hazardous thing even if the Bush administration had been right and Saddam Hussein had assisted al-qaeda materially and had possessed weapons of mass destruction would voters today be grateful that they did not have to experience whatever scenario was averted by his overthrow the adverse consequences of the u.s. invasion were always bound to loom larger than those of a hypothetical future in which Saddam acquired WMD by contrast the decision-makers at the Federal Reserve came to appreciate relatively swiftly that not to do everything in their power to avert a second depression would have been more hazardous than to do everything and this was partly because Geithner not coincidentally a kissinger protege so ably made the case for action whatever risks Bernanke and his colleagues ran after the failure of Lehman whatever unforeseen costs their innovations may Turner to have incurred most of us can agree now that they were probably worth it but that is mainly because we can better imagine a hypothetical future in which the monetary policy mistakes of the 1930s were repeated ladies and gentlemen risk management is in many ways a misleading term for the most difficult challenge of policymakers in both finance and foreign policy is to cope not with risk but with uncertainty with dangers to which probabilities cannot be attached to my mind it will not be enough in future merely to break down the walls that currently separate the people in the security analysis silo from those in the securities analysis silo we need to introduce in both these fields a more rigorous notion of applied history and a recognition that the value of history lies precisely in teaching risk managers of all kinds to interrogate explicitly their unspoken assumptions thank you very much does any of this risk management studies have made them much on in the way of climate change and worst-case scenarios actually yes one of the striking things that characterizes the climate change debate is how much effort has gone into making scenarios in which the planet heats to different degrees and Nick Stern began I think the systematic study using quite elaborate climate models some years ago now with the stern report what's interesting about this as a policy problem is that most voters struggle with dangers that are as distant in incidence as a hundred years and so it's quite important there in the most recent debate that the time horizon for disaster has been brought forward what one I think reason it took a while for climate change to be accepted as a major problem on the on the right was that it seemed a very remote danger compared with say nuclear war which could happen tomorrow so I think it's it's a good question to ask the problem is of course can governments successfully grapple with the trade-offs that are inherent in all in all mitigation strategies and I'm inclined to be more optimistic than average here despite the Trump administration's decision to walk out of the Paris climate agreement I actually think the United States will continue collectively to reduce emissions because of its relatively decentralized structure so that what's happening at the state and city level is is probably just as important as what's been decided in in Washington there's a gentleman over there with a hand in the air yeah I'm dr. Bruce Bowman I'm in the medical field and in my field we project that the next major financial crisis in this country will be due to the cost of healthcare and so how do you see we might use our knowledge of history to try to avert that situation it's a facet my father was a physician and so I grew up in a medical household I'm the black sheep of the family I I think one of the amazing things about the health care reform debate in this country and I've lived and worked here since about 2002 and despite my funny accent I'm an American citizen is the lack of reference to other systems and the general ignorance of the history of the very strange American system the system of employer-based health insurance is a kind of quirk of US history an accidental byproduct of World War two policy it's a very unusual system it doesn't really have any counterpart in the rest of the world and what would be easy and indeed it has been done would be to look at the different healthcare systems in the world since all populations confront the same basic problem it's just that you know some drink more soda than others but broadly speaking the same problem exists for any state we have any number of of options to choose from it's not hard to see that the Swiss system is really a lot better than the American system one shouldn't as often the case make this a choice between the United States and Canada I mean I hear debates on this issue that imply we are in a two country world but but actually we're in this hundred and ninety five country world where you just need to see where bad best practice exists so it's easy to see that that single-payer isn't necessarily the the only option here that you can have insurance based systems like the Swiss system that deliver extremely high quality extremely good outcomes at relatively low cost in terms of shares of GDP that's the easy bit though again it's almost wholly absent from public debate I can't remember the last time I saw an article in a major newspaper or magazine that spelt out the relatively simple nature of the choice that we face the difficult bit is getting from our broken system to any other system in the face of incredible vested interests that make a huge amount of money from it I had a phase perhaps it was the the kind of phase everybody goes through when they first moved to Stanford the OU technology will fix this phase if you spend any length of time near Silicon Valley you you go through this phase and it seemed so obvious so well this is just an amazingly inefficient system that you can solve with big data all we need to do is get the data and off we go but the people who've tried to do that have encountered the vested interest problem it's it's a political economy problem ultimately more than a problem of picking the right system so here I think that the problem is different from climate change just to draw your two questions together that's considerable uncertainty about what exactly the consequences of climate change will be anybody trying to model the Earth's climate is is in a in an incredibly complex domain in strict terms this is where complexity rules but when you're trying to figure out what's going to happen to the US healthcare system it's really quite straightforward there's a enormous fiscal crisis baked into Medicare and Medicaid and and I think it's fair to say that whatever patch on the operating system of Barma care was it didn't fundamentally alter the the trajectories so here we don't have the kind of uncertainties that we have in the case of climate change an irresponsible American government can gamble that the effects of climate change will be much worse in SE Asia than in North America I think that will probably turn out to be right but there is no kind of need to be conjectural about the healthcare problem you either do some radical reform of the system or it becomes fiscally unsustainable Larry Kotlikoff at Boston University did the math more than 10 years ago if you carry on in the project present trajectory I either have to face a drastic cut in entitlements for the next generation or a massive increase in taxation there's no other fix I'm trying to make sure I'm even-handed in in roving the room and also what I'm striving for gender balance ladies but you're you're not helping me here yes sir my wife doesn't consider myself a man might mean to be a man so anyway that joke you comment on it laugh about those things anymore sorry what about Trump and NAFTA and terrorists with China what do you see there well it's a it's a great question and future historians may have to write papers about the the consequences of of the escalating trade war between the US and China I think I have a kind of ambivalent attitude towards much that this administration does and that distinguishes me from most academics who who are entirely negative about it I'm a free trader I was raised on Adam Smith I studied comparative advantage like most of the people in this room and so from a narrow economics point of view it makes no sense to impose tariffs on imported goods from China but this is not a narrow economic policy it is part of a broad attempt to contain China's rise and if indeed that is still possible and I think that if you ask the question in geopolitical terms what do you as the incumbent power do about the rise of a challenger that is on track to overtake you economically and potentially on track to overtake you over a longer time horizon militarily the answer is clearly not nothing nothing was kind of what the last two administrations did despite talk of pivots to Asia the Trump administration at least is doing something about the Chinese challenge but what we can't know and this is the problem of conjecture perfectly illustrative we cannot know what the consequences will be we can only conjecture so in in Trump's administration the thinking is if we do this now using not only tariffs but other policy tools to check China's rise we stand a chance of avoiding a world in which China is the number one power and we are a number two I think that's that's the core of what is being done here what's the downside risk well there's obviously an economic downside risk that if there's a trade war between the two major economies in the world it's likely to have some negative consequences who knows perhaps today is day one of the the Trump crisis and the end of the Trump boom nobody in this room has any certainty about the timing here that the peak Trump moment might actually be last week might actually be the confirmation of of cavanaugh we can't be certain and the reason we can't be certain is that there are all kinds of variables here which are really really hard to predict for example I was in Beijing just two weeks ago the effect of the trade war on China's political stability is very striking I've never seen the people in Beijing so divided I've never heard so much criticism of the leadership in private much of the blame is is actually laid on Xi Jinping by educated Chinese who see that his proclamations of China's great power status brought this down upon China's head so one unintended consequence or perhaps it will turn out to be intended of this policy might be to destabilize the Chinese regime it's certainly administering a shock to China's economy it makes it very hard for the regime to continue with its deleveraging strategy now in parentheses one of the great unknowns China is at what level does the debt get to before growth becomes negatively affected up until this point China's performance has has been increasingly reliant on debt creation especially in the last 10 years since the financial crisis what is the upper bound is there a financial stability problem in China they worry about it which is why they said they were going going to D leverage the trade war has put all of that on hold and now the orders to local government are once again issue bonds do infrastructure investment so what Sun Nobel and it's it's it's a great illustration of the problem of conjecture is what the impacts will be in China if China were to be destabilized in the way that the Soviet Union was by Ronald Reagan's increased arms expenditure in the early 1980s future historians might have to give President Trump a much better report than anybody in Princeton New Jersey is inclined to give him right now we just can't know but I think what's clear is that that the regime change in foreign policy has this to be said for it the status quo continuing with the strategic patience doctrine of the Obama administration pretty much guaranteed that China would overtake the United States economically and at some point also militarily this is not the strategy I would have recommended but it is at least a strategy let me add one final point my friend at Harvard Graham Allison published destined for war a book that sets out the so called Thucydides trap problem this is a good work of applied history that forces policymakers to address the question how should an incumbent power deal with the rising power and all to put it more precisely how does the United States avoid being Britain to China's Germany in the 21st century that's a really important question for policymakers to grapple with and I'm encouraged by the that in both Washington and in Beijing there is a serious discussion about that question because it's that kind of approach that I'm advocating let's sit down and think of the analogies and try to see what we can learn from them you can find all kinds of faults with Grahams book and I've done it myself at times but at least it faces us to ask a historical question about the central strategic problem of our time thanks I'd know lost track of the microphones yes at the back please sorry I'm just an interested citizen just building on your last comment about facilities what what might the applied lessons of history or the lessons of applied history what might that look like for a course of study or how do you how would that work well I try to be an interested citizen too if we were all interested citizens things would go really well in this in this great Republic if I would teach you of course I'm not teaching at Stanford so I don't have to grapple with this it would be somewhat similar in its in its approach to Graham's book in other words I'd want students to look at a series of case studies when a an incumbent power faced a rising power you know a thens and Sparta's ethnicities is case study but you can go forward from there and look at a whole succession the rise of England posed a major threat to the Dutch Republic the rise of France to England and so forth the best analogy and the place I lead my students would be the rise of Germany and the stand the challenge that it posed to Great Britain because I think that's the best the best fit here why do I think that because the United States today occupies a similar place in the world to the British Empire in the period before 1914 it's unquestionably dominant and whole range of different domains from the economic to the the military but there is this rival that is growing more rapidly that is acquiring technological superiority in some domains notice China has a better electronic payment system now than the United States it's AI capabilities probably now as good as those of the United States and the two economies and this was also true of Britain and Germany are quite strongly interdependent so the puzzle is what what do you do I call this problem the Chimerica problem in 2007 that China and America had sort of fused economically they'd become highly interdependent but that was also true of Britain and Germany before 1914 and yet conflict came the correct inference I think is that in both 1900 to 1914 and in the 1930s Britain failed adequately to deter Germany from taking a very risky gamble on military action and that failure to deter came mainly from fiscal constraints on on expenditure if you follow the analysis of my books the pity of war and war of the world through then a better prepared Britain a Britain that introduced conscription before 1914 or or a Britain that really built up its defense capability in the 1930s would have a student least some chance of avoiding a war because it would have made the gamble just too risky for Germany whereas of course Britain had almost no land forces available in 1914 and therefore couldn't really deter the Germans from there from launching their invasion of of Belgium and France so I think that's where a course would want to delete students or at least to give them a chance to think about these issues of course the conclusion that you arrive at is a slightly a charm master type of conclusion that the u.s. does need to Croesus defense capability and it does need to be more assertive in the asia-pacific region to discourage China from building up its military capability at the moment China does not seem deterred it's certainly not deterred in the South China Sea where it's rapidly building naval and military capability it's not deterred from building up its its missile equipment that can pose a real threat to American aircraft carriers it's not deterred from its quasi Imperial belt and Road initiative and that there's no real sign that anything we are doing is or at least there's not been until recently any real sign that anything we're doing is checking China's ambition oddly enough the trade war seems to be having at least some effect it would be a fun course to teach I think you'll have to go to Harvard's Kennedy School if you wanted I didn't quite catch what you said sir especially for the FOMC in the National Security Council well it would I think and this is an argument I've made with Graham Allison we made this an arguments and a piece for the Atlantic a couple of years ago it would be good if policymakers at some point in their careers studied applied history because I'm very struck by the lack in in the US government of a place for the study of historical precedents it tends not to happen and this is an institutional failure I I came to realize working on the Kissinger biography that there's a kind of United States of amnesia problem in which each administration starts with a tabula rasa and and forgets everything that its predecessor did and this was illustrated for me very vividly when one of the readers of the first volume of the Kissinger biography wrote to me and said with reference to the 1965 66 67 chapters which described kissinger's visits to Vietnam before he was in government and his his critique of US policy in Vietnam my correspondent who had been in the Bush administration said I was amazed as I read those chapters how like our experience in Iraq it was and I was amazed that he was amazed I think there's a question here and then there's one there unless somebody already has the microphone what gentleman there and then there's a couple of gentlemen here and still the lack of female questions is a concern hi Jeff Laurenti a friend of the Institute if I can take you back to the substance of your lecture of a question on that perhaps one other factor that you have not accounted for in this evenings discussion has been the relative lack of ideological blinkers in addressing the financial crisis and the very real ideological blinkers that at the start of the Bush administration its national security people brought I mean you quoted dick Fisher about the gospel of Saint Milton Friedman and there were no saint Milton Friedman nights at the table at the time that you were describing 2008 you had the realists of Bernanke Paulson Geithner who weren't blinkered by ideological kinds of obsessions and and ruling out of contradictory facts whereas in 2001 you had people Cheney Rumsfeld who were very determined to assert American supremacy American hegemony before the Chinese became a threat and who were impatient with multilateral hand-holding they thought the consultations that the Clinton people had to do over Kosovo just impaired the military effort that the Americans could do by themselves they weren't particularly anxious with their NATO allies who thrust upon them an article 5 resolution at NATO the French and the British who thrust upon them Security Council resolutions at the UN you had an ideological dimension the national security side in the early years of the Bush administration that ruled out unwelcome facts and that drove them to in directions that would prove ultimately disastrous do you think that this question of realism versus ideologies may be a useful thing to supplement or consideration your argument thanks that's a great question and I appreciate your addressing the body of the talk it's tempting to say yes neoconservatism played this fateful role in 2001 where as well you've anticipated something I was going to say whereas pragmatism was the the order of the day in 2008 but I think there's a need for nuance here because they weren't just neoconservatives and you've already guessed the point that actually Cheney and Rumsfeld had had a kind of load of baggage from previous eras going all the way back to the Nixon era that was quite different in nature from the baggage that say Paul Wolfowitz or Doug Feith were carrying I mean there were neoconservatives in the administration but it's striking to me that they weren't decisive players in 2001 when the crisis struck condi rice I don't think really could be characterized as a neoconservative and when I look at what Cheney and Rumsfeld were arguing I'm struck by the fact that as as often with them the kind of administrative game within the beltway loomed larger than events in Iraq or Afghanistan which seemed to be kind of shadows on the wall everything was about the Beltway battle the interagency rivalry could you stick it to CIA above all could you stick it to state could you make sure you stuck it to the generals I mean that was Rumsfeld's I think that was his main priority and I think it's why the policy ended up being so bungled because in the end what happened on the ground was of sec any concern - what happened within the Beltway within the Beltway the strategy was brilliantly designed to enhance the power of the secretary of defense at the expense of everybody else but from the point of view of defeating terrorist organizations or or stabilizing the countries that the u.s. intervened in it was a pretty disastrous policy I'm also struck by the fact that Bush himself quite quickly embraced a kind of liberal internationalism partly under the influence of people like David from the speeches very quickly starting with 2002 became infused with a kind of messianic vision that you were going to achieve gender equality in Afghanistan that you were going to create shining democracies in the countries that the u.s. invaded so what most strikes me about the Bush administration in the critical moments between 2001 and 2003 is that actually there were quite a lot of ideological strains at work and no one was was clearly dominant but the least that the it seems to me the least important thing in practice was actually neoconservatism that provided a sort of intellectual window-dressing but what was really driving this process was what my old friend Morris cowling would have called high politics or low politics to be more exact these these Beltway battles the accidental byproduct of which were the invasion of Iraq meanwhile on the FOMC while it can appear from the transcripts that a bunch of well-trained pragmatists were were figuring out what to do about the biggest financial crisis since 1929 that may be a little deceptive economists have their ideologies after all the freshwater versus the salt water those differences became very visible in the period after 2008 but what I'm struck by is that in the sheer panic that followed Lehman's bankruptcy all the things that economists are taught to value especially models were just cast aside it was obvious to anybody who was remotely engaged with the reality that the staff economists were smoking something as they as they intoned their projections for the following year and in fact throughout the entire period of the financial crisis the professional forecasters with their models were consistently wrong every single year about what was going to happen I mean to the point that they were so predictably wrong that you could more or less accurately predict what would happen by just believing the opposite so I think what happened in the crisis was that faced with the uselessness of the model which after all was a kind of antique from the 1970s the thinking people around the table particularly Bernanke and Geithner well what had to fall back on on history it wasn't that they didn't have any ideology it was just that the ideologies of macroeconomics were totally useless at that at that moment but thanks for a great question yes I've forgotten who else there was the gentleman the blue shirt has his hand up and the gentleman the black shirt is Nix I think Steven Brent I want to stipulate that I agree with you that it would have been a great idea in the case of Iraq to look at the at history and you but you you'll you only mentioned as far as I could hear one kind of historical case to look at which is what has happened in cases of preemption and you mentioned Kissinger warnings about that I think the policymakers and by the way I disagree completely with the Iraq policy but the policymakers at the time could say there are too many new variables in this mix the old his the whole analogies to historical events won't hold we've got a situation where we have got great resource now we have had some success with interventions for nation building we have this idea that was circulating at the time of the end of history even with liberal democracies faded to take over the entire world and I think they could easily say and you mentioned the word conjectures that we can't take into account the variables that are new and so the historical analogies that we look at might be misleading what do you make of that there was certainly a lot of that's in there after 9/11 I mentioned I often Bush himself talked about an unprecedented challenge a new a new world and I think there was a kind of strain of thinking that had had been quite fashionable since Frank Fukuyama's end of history to encourage a certain hubris one one has to remember that by the time of of Bush's election there was a kind of cottage industry of academics writing articles about the unipolar moments the the full-spectrum dominance that the u.s. enjoyed and in the military realm and the the disquiet that I expressed at the time when I made comparisons with the British Empire was definitely the minority view so what one illustration of this point is that as the discussions about the invasion of Iraq took place in 2002 there was almost no discussion at all of any previous invasion of Iraq which was odd to me as a historian of the British Empire since we had so often been there done that and got the medals the the british invasion of iraq was as with most British invasions first disastrous and then ultimately crowned with success but one of the disasters was an enormous insurgency that that occurred in 1920 it this was entirely unknown as an event in Washington in 2002 I know because I would periodically bring it up I remember having a conversation with a young person in the government and I asked what their model for post-saddam Iraq was and she replied well Poland after communism I looked at her and I said have you ever been to the Middle East she looked at me as if that was a stupid question and said no I mean she I presumed been to the Kennedy School or somewhere like that but she she seemed perfectly unaware that the the the analogy between post communists in Poland and post-saddam Iraq was worse than useless it was positively dangerous so in my longer version of this I go into why it was that nobody thought at all about the British experience in Iraq and nobody considered the possibility that you might well be able to topple sit down but then you might face the kind of insurgency that Britain faced and in the context of 2003-2004 the odds would be overwhelmingly in the favor of the insurgents because the population of Iraq was vastly larger in 2003 than it had been in 1920 and there were far more weapons and far more dangerous weapons so this was just not there it first crept into the discussion when junior officers in the field started who were who were trying to figure out what the hell was going wrong started to read about it and I would get emails from people in you know outside Fallujah saying can you tell us more about the insurgency that you guys had to deal with and they they hadn't been at any point told about the history of Iraq now this is this is not exactly high hanging fruit but I think it was symptomatic of the the problem that there was no real serious consideration of the downside risks of sending a military force into Iraq and I think that's the critical issue here where if if there had been a point in the decision-making process at which they just sat down and read a bit or had someone read to them a bit about what had happened in in the British experience in Iraq they might at least have reflected on the dangers of an insurgency instead of which it came as a complete surprise I hope that answers you'll I hope that answers your question I have a sense as people are standing that we were closely approaching the end of our evening but there's one last question the gentleman and the blue shirt has been patiently waiting to ask yes sir well if my old friend Harold James were here he'd probably bill to give you a better answer than than me as as Harold's written widely on these questions of of currency regimes let me um let me offer you a brief answer and then and then we'll call it a night firstly I think we should ask what the unspoken assumptions or the that the the frameworks are that are informing this policy now most people in academic towns like this one I find have an instant an extremely low opinion of the president's intellect and indeed the the Saturday Night Live view generally prevails in academic circles there's a tendency to forget that the administration is more than just him and that actually the policy that has evolved around China is the products of many hands including some extremely experienced ones say Jim mattis at a DoD mattis hooba in a previous role had to draw up the US war plan in case of conflict with with China so I think we shouldn't underrate this administration simply because we have a low opinion of of the president's own intellect in any case the president has some powerful intuitive gifts that shouldn't be underestimated for example he has this curious animal instinct for the weak spot of the counter party and he found it in Jeb Bush he found it in Marco Rubio he found it in Hillary Clinton I think he may have found it in Xi Jinping but the policy itself could be we don't know but it could be simply limited to using tariffs to achieve a more a fairer or preferable from an American point of view trading arrangement in that case it would be a rerun of the 1970s playbook and we would simply say this is not unprecedented it's roughly what Nixon Ford did with respect to Japan but there's a scenario in which this is just the overture to something more like Cold War 2.0 and if you listened as I did to Mike Pence's speech the other day on China then the probability of this thing escalating is not trivial and I think it will escalate and it will go beyond the realm of tariffs and it will enter the realm of of strategic questions South China Sea and Taiwan I've come to the conclusion this is the last thing I'll say that the United States can win the trade war and it could win an actual war though it wouldn't be as easy as some people think even now but the currency war is the dangerous one and the reason I say that is this it's true that the u.s. remains completely u.s. dollar remains completely dominant in trade and in international reserves and when the Europeans say oh we wish we had another payment system so we didn't have to put up with American sanctions it's kind of pathetic but what is happening which is extraordinary is the speed with which the Chinese online payments platforms are spreading globally and as aunt financial roles are at a payments platform throughout emerging markets that is clearly superior to anything that the US has to offer we may see a meaningful shift towards the use of RMB backs of Chinese currency backed payments that would be a profound shift in the international financial order but it's not going to happen overnight that's the thing to watch history helps one think about these things and in the end I see no other way of understanding them to understand how a currency regime changes how one currency sisters ceases to be dominant another takes precedence I don't think a model can offer an answer to that question no matter how brilliant your mathematics ultimately we have to understand why sterling ultimately yielded first place to the dollar in that sense I think applied history has a tremendously important role to play not least here at an institute like this one because until we integrate history and give it as it were equal status with hard science and social science we'll be missing a really vital dimension of explanation I don't deny that history is quite messy because the particles we study have consciousness and that does make them very troublesome compared with atoms but please if you are one of the mathematicians or physicists who who predominate at the Institute do take history seriously and when you're next in the cafeteria sit next to Jonathan and engage him thank you very much indeed [Applause]

Channel: Institute for Advanced Study

Views: 85,983

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Id: LeWZ8hw7Yr0

Length: 84min 15sec (5055 seconds)

Published: Thu Oct 11 2018

Reddit Comments

[u/1913intel]

The two crises are the 9/11/2001 terrorist attack and the 2008 financial crash. Niall focuses on the bankruptcy of Lehman Brothers as a proxy for the 2008 financial crash.

I've been talking about those two crises for years. They are connected by time. They are not independent events. When a forest is ready to burn down to the ground, prior to the terminal fire, one might see an unexpectedly intense fire in one or more separated areas - though they can be put out. The separation of areas is irrelevant. They are all connected by time and stability. And as a consequence, the internal problems have had the same amount of time to grow in all areas.

Crash = Time + Stability

[u/1913intel]

My comment at YouTube.

While Niall Ferguson's conclusion about applying historical analysis to crises is a good one, I believe his talk really missed the key points of the two crises in question: 9/11/2001 and 9/15/2008. He focused on the reaction to the events. He should have focused on why the events were allowed to happen in the first place.

Why did the financial crash of 2008 happen? Many people made a lot of bad decisions. Suppressing the crash simply allowed all those people who made bad decisions to keep their jobs. And in the future, after things settle down, they can work their magic all over again. And they have been working their magic again. Now we have to worry about an even bigger crash coming.

Why did 9/11/2001 happen? The rise of political correctness and all the baggage it contains. By not addressing the political correctness issue the country remains vulnerable to some other kind of attack. I'm thinking about an attack from another great-power.

Societies crash just like forests do. It is well known that suppressing crashes (putting out fires) in a forest just make things worse in the future. So too with societies as I just showed above. Failure to respond appropriately to 9/11/2001 and 9/15/2008 means the situation is now much worse. Let's see:

1. Talk of a civil war.
2. Talk of another big financial crisis within a couple of years.
3. Talk of a trade war with China
4. Talk of another cold war.
5. Talk about the possibility of a great-power war.

The West is a forest that is ready to burn down to the ground. Now we wait for a hot, dry summer and a spark.